NY futures continued to push higher this week, with March gaining another 110 points to close at 75.33 cents.

Last week March posted a 7-month high and today it reached a 9-month top, closing just 24 points shy of its contract high. The story remains the same, with the market still facing sell-side illiquidity, as spec buying and bullish options strategies by the trade continue to feed this bull move.

Tuesday’s WASDE report was a mix between bearish US and bullish world numbers. The government still sees a US crop of 21.44 million bales, a view we don’t share since we don’t believe that Texas will make 9.5 million bales, or 1.4 million bales more than last season’s bumper crop.

The USDA finally started to trim some of the phantom stocks in India (-1.45 million bales) and Pakistan (-0.4 million), but they are still too high and further cuts are needed to bring them in line with reality. In total global ending stocks dropped 2.88 million bales to 88.0 million bales.

Since September the USDA has decreased global production by 0.79 million bales to 119.96 million bales, while boosting global mill use by 1.84 million bales to 119.59 million bales. Combined with some downward adjustments in inventories it added up to a steep drop in the ROW ending stocks estimate, from 53.07 to 48.33 million bales.

We feel that ROW stocks are going to be even lower, somewhere around 46.0 million bales, which would still be plenty of cotton when compared to previous years. Since the extremely tight 2010/11-season ROW ending stocks have ranged between 37.2 and 44.2 million bales. In other words, we are still looking at a record ROW carryout this season.

However, since there are some quality issues in the US and India this season, premium grades may not be more plentiful than in the previous two years. This is reflected in the strong high-grade basis, which is part of the reason why the futures market is so well supported. Furthermore, with Chinese imports likely to double or even triple over the coming years, there will be plenty of demand for ROW stocks going forward.

US export sales remained at a robust pace last week, as another 305,800 running bales of Upland and Pima were sold for both marketing years. Shipments of 180,300 running bales were slower than expected and this is a concern, since outstanding sales are at 8.0 million statistical bales, the second highest ever after the 2010/11-season. Total commitments have now reached 10.8 million statistical bales, of which just 2.8 million have so far been exported.

The weekly CFTC “on-call” report reminds us of the old saying “when in a hole, stop digging”! We are quite amazed to see that unfixed on-call sales keep going up, with 14.75 million bales yet to be priced, whereof 5.58 million bales are on March, 2.97 million on May and 3.07 on July. For March fixations this means that with 44 sessions to go until FND, mills will on average have to fix around 127k bales per day or about 1270 contracts. That adds up to a lot of support!

So where do we go from here? Speculators have so far led the charge in this bull move and increased their net long by around 7.0 million bales since July. The trade has been slow to react to this rally, not really believing it could happen, but as it is often the case we are now seeing defensive moves via bullish options strategies helping to fuel the advance.

Momentum indicators have been in ‘overbought’ territory for about three weeks now, which means that a correction is possibly at any time, but it will take more than a couple of cents to flush out these stubborn spec longs, and with 5.6 million bales in unfixed on-call sales on March alone, a trend reversal is not likely at this point.

If the trade starts to panic and pays up to cover shorts and/or fix on-call sales, this move could get extended by several more cents, especially since a breakout to new contract highs would attract additional spec buying. If the trade plays it cool and the spec buying exhausts itself, it may lead to a dip of 2-3 cents, but much more is not in the cards in our opinion since there is simply too much pent-up buying waiting underneath and we don’t see the force on the sell side to overwhelm all these buyers.

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